The cash flow of your small business is one of the most critical components of your success or failure. Over the years, academic studies have found that problems in the cash flow of small businesses are the main reasons for their ruin or bankruptcy. Without money in cash, big incomes don’t have any meaning. Many businesses that are profitable in paper end up in bankruptcy because the amount of cash inflow doesn’t compare with the amount of money going out. Also, a company without proper cash management may not have the ability to invest and thus compete, or may even have to pay more when asking for a loan. This is why we are here to help you optimize your cash flow.
Other reasons for the failure of small companies are the lack of experience, a bad location, a bad management of inventory, and overinvesting in fixed assets. But in this article, we’ll focus on cash flow. First, we will explore some critical concepts that will help you understand and appreciate the relevance of proper cash flow management. Then, we will show you some practices to improve and optimize your cash flow.
What Is Cash Flow?
Before we fully immerse into the subject, it is necessary to know what CASH FLOW is. It is simply the in and out movement of cash in your business. It’s controlled weekly, monthly or quarterly. There is essentially two types of cash flow:
- Positive cash flow: When the cash received from sales, accounts receivable, etc., is higher than the quantity of cash that is going out for accounts payable, monthly spending, salaries, etc.
- Negative cash flow: When the cash outflow is higher than the cash inflow. This generally means problems for a business, but there are measures you can take to fix the situation and generate or collect more money in cash, with either cutting or eliminating some costs.
Achieving a positive cash flow isn’t something you only get by chance. You have to work for it. It’s necessary to analyze and manage the cash flow to have a higher efficiency in the control of inflows and outflows. The majority of the accounting software packages oriented for small or medium sized companies will help you make a cash flow statement. There are also many online websites that offer free templates to facilitate your job.
What’s the Difference Between Cash Flow and Income?
Another concept that needs to be managed is INCOME. It is important to know that it is not the same as cash flow. In fact, income, as defined by the rules of accountability, is simply the result of the revenue minus spending. But the cash flow of small businesses, or companies in general, results from many other financial figures, including accounts payable, capital spending and debt services. Smartly managing the cash flow of small businesses implies focusing on each one of these elements.
Surely, the cash flow of small businesses must be positive to generate income. If we apply the logic, we will understand that you need enough money to pay employees and suppliers that do or facilitate the process to elaborate and sell products. This sale of products is what helps generate income. But if the company doesn’t have enough money (cash flow) to make the product, then there will be nothing to sell, therefore there will never be an income. Hence the importance of structuring a company correctly to have a positive cash flow.
The whole process of watching a business grow is circular: You must dispose of cash to make investments and carry out certain spending; this will lead to upgrades, that will lead to higher income, new cash flow, and successful growth. The cash flow of small businesses can be seen as a tool to achieve goals.
Business owners can usually see growth as a solution to the cash flow problems, since making a business grow also increases your money in cash. However, there’s a risk of not managing yourself correctly during the process of growth, when the disbursement of cash is constant and, many times, in advance.
How Can I Optimize Cash Flow?
There are some practices that can be used to better administrate the cash flow in your small business.
Action #1: Review and quicken the accounts payable
To improve the cash flow of small businesses, the first option is to quicken the receipt and the process of the accounts payable. You can use strategies that will facilitate the traffic of money towards the company without bothering the client. For example, you could:
- Enable mailboxes attended by banks so that clients in remote locations can send payments by mail.
- Request previous authorization or confirmation from clients for your checks so banks can process them in fewer time intervals.
- Centralize your bank accounts.
- Provide your clients with various forms of payments: transfers, checks, cash and credit card.
- Offer discounts to clients if they pay their bills quickly.
Action #2: Adjust requirements for sales by credit
Companies frequently have to extend their clients credit, especially when they’re beginning to grow. Nevertheless, the cash flow of small business can be vulnerable and prone to vanish in credit sales. Therefore, it’s necessary to previously investigate the risk of extending each client’s credit. It’s necessary to know if they can pay their bills on time or if their business is really growing. Perhaps they really have problems with liquidity and could use the growth as an excuse to evade payments. It’s advisable to make detailed reports about the client in question and ask them to fill out a credit form. You could also consult the references. Another option to improve the income by credit is by accepting credit cards. This will cost a percentage, generally of two or five percent of each sale, but it could be a safer bet to receive payment for a sale at the moment.
Action #3: Increase sales
This is an obvious recommendation, and surely you already had it in mind. If you need more money in cash, it seems elemental to attract new clients or sell products or additional services to your current clients, even though this could be more complicated than it sounds. Obtaining new clients is essential for a growing business, but it can take time and money to realize sales. On the other hand, selling new products to existing clients can result to be cheaper and more achievable. However, it’s possible that increasing sales on the same client could only increase the accounts payable and not the cash flow if these sales are by credit.
Action #4: Offer discounts and promotions
One strategy to increase the cash flow of small companies is by offering discounts and promotions to clients if they pay on time or ahead of time. This practice can affect your margin of income. Incentivizing the clients to make payments before the required billing cycle can also help manage your cash flow. Your company can also take advantage of this mechanism to pay its own suppliers and debts ahead of time. But be cautious, so that these early payments don’t leave you with a deficit on the cash flow.
Every company, big or small, must know each month what their closing cash balance is and how they want to close next month. This will help project themselves, plan, and correct situations that they don’t want to be repeated, When you manage your cash flow efficiently, it’s easier to make business decisions about the expansion of the company and the maintenance of the bills and existing clients.